Sterling Construction Company, Inc. — Form 10-Q Summary
Business Context and Reporting Period
The filing covers the quarter ended March 31, 2017. Sterling Construction Company, Inc. is a heavy civil construction contractor serving transportation infrastructure, water infrastructure, and residential and commercial concrete markets across several U.S. states. Interim financial statements are unaudited, and management notes that results are subject to seasonal variation.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $153.4 million | $126.6 million | Up 21.2% |
| Gross profit | $9.3 million | $3.5 million | Up $5.7 million |
| Gross margin | 6.1% | 2.8% | Up 330 basis points |
| Operating loss | $1.8 million | $6.5 million | Improved $4.7 million |
| Net loss attributable to Sterling stockholders | $2.3 million | $7.3 million | Improved $5.1 million |
| Loss per share | $0.09 | $0.37 | Improved |
| Operating cash flow | $(3.1) million | $0.5 million | Decrease of $3.6 million |
General and administrative expense increased 5.1% to $10.6 million, but declined to 6.9% of revenue from 8.0%. Interest expense fell to $0.1 million from $0.9 million as debt outstanding declined. The company recorded minimal income tax expense and maintained a full valuation allowance against net deferred tax assets.
At March 31, 2017, cash and cash equivalents were $37.1 million, down from $42.8 million at December 31, 2016. Working capital was $29.2 million versus $29.3 million at year-end. Total debt was approximately $4.3 million, including $2.5 million under the equipment-based term loan and $2.4 million of equipment notes, partly offset by deferred loan costs. No revolving loan balance was outstanding.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by the ramp-up of large Utah joint-venture projects and large Texas and Utah projects; California activity declined as a large project wound down.
- Gross margin improved substantially because of better project execution, higher backlog margins, and the completion of lower-margin legacy projects.
- Backlog increased to $925 million from $823 million at December 31, 2016 and $854 million at March 31, 2016. Backlog gross margin increased to 8.4% from 7.7% a year earlier.
- Operating cash flow turned negative because contract capital consumed $6.6 million, including increases in receivables and costs in excess of billings.
- The first quarter remains seasonally weak; management identified approximately $1.5 million of under-absorbed overhead that it expects to recover through higher activity later in the year.
Guidance, Outlook, Risks, and Unusual Items
Management did not provide formal revenue or earnings guidance. It cited favorable infrastructure funding trends, including federal and state transportation programs, and expects improved bidding discipline and project execution to support margins. The company believes it has sufficient liquidity for the next twelve months, including bonding requirements, but cautions that substantial cash constraints, losses, or difficulty obtaining financing could materially impair working capital.
On April 3, 2017, after the reporting date, Sterling acquired Tealstone Residential Concrete and Tealstone Commercial for preliminary consideration of $83.7 million, consisting of $55.0 million cash, 1.9 million Sterling shares valued at $17.1 million, $4.4 million of promissory notes, and $7.2 million of discounted deferred payments. Additional earn-out payments of up to $15.0 million may be made if performance and employment conditions are met.
The acquisition was funded alongside a new $85.0 million secured term loan maturing April 4, 2022. The loan bears interest at LIBOR plus 8.75%, includes substantial restrictions and financial covenants, and requires quarterly offers to prepay 75% of excess cash flow. Sterling also issued five-year warrants for up to 1.0 million shares at an initial exercise price of $10.25 per share.
Material risks include construction cost overruns, project delays, weather, change-order and claim recoverability, dependence on government infrastructure spending, subcontractor and joint-venture performance, fuel and material inflation, acquisition integration, and the cyclical residential housing market. At March 31, 2017, the company recorded $0.4 million of unapproved change orders, $10.3 million of claims, and $3.9 million of entitled unpaid project price in costs and estimated earnings in excess of billings. Management expects resolution without a material adverse effect, but actual recoveries may differ.
Unconsolidated joint ventures had approximately $93 million of remaining construction work, including $47 million attributable to Sterling. Joint-venture arrangements generally involve joint and several liability, although management was not aware of any current matter requiring Sterling to assume a partner’s obligations.
Investor Verification Priorities
- Verify the final purchase-price allocation, goodwill and intangible assets, pro forma results, and segment presentation for Tealstone.
- Monitor compliance with the new loan’s secured-debt-to-EBITDA, cash-collateral, backlog-margin, capital-expenditure, bonding, and Tealstone EBITDA covenants.
- Assess whether backlog conversion and improved margins continue, particularly after seasonal first-quarter effects.
- Track collections, contract assets, claims, unapproved change orders, and operating cash flow.
- Evaluate dilution from the 1.9 million acquisition shares and potential 1.0 million warrant shares, plus the cash and deferred payment obligations.
- Review exposure to joint-and-several liabilities, project losses, litigation, weather, labor and materials costs, and residential housing-cycle conditions.